Loan stacking, which is when a borrower takes out multiple business loans from different lenders at the same time, is becoming increasingly common. The percentage of borrowers who stacked loans doubled between 2013 and 2015. And that number continues to grow.
Since the 2008 recession, banks have cut down on lending to small business owners. In response, many are stacking two—or sometimes even three or more—loans from online lenders to start and grow their businesses. Although this might work out for a few, most entrepreneurs simply aren’t able to sustain that much debt. And loan stacking is bad for lenders, too, who might lose out to other creditors if the borrower defaults.
Find out more about the risks of loan stacking, as well as three alternatives if you find yourself in need of more capital after getting a business loan.
Loan stacking is when a borrower has multiple loans outstanding at the same time. People use this term most often when borrowers apply for and receive approval on several short-term business loans in short succession, each having similar interest rates and repayment terms. In this case, you’re not refinancing one loan with another but taking out multiple loans at once—hence, stacking them.
Plus, in this case, a borrower would have multiple loan payments actively due, too. Having simultaneous loans can negatively impact a borrower’s ability to afford the loan payments. And if the borrower defaults, the presence of multiple creditors can make it difficult for each lender to get their money back.
On the surface, stacking loans might seem pretty harmless, especially if business is good, and you’re having no trouble making payments on your current loan.
However, loan stacking carries two main risks:
Let’s look at both in more detail.
At its core, says Greg Hockenbrocht, a business loans specialist at Fundera, loan stacking negatively impacts a business’s ability to pay back debt.
“When you apply for a business loan,” Hockenbrocht says, “the lender looks at your business’s cash flow to evaluate your ability to repay the loan. And when you take out multiple business loans, each lender depends on that same pool of cash to get their money back.“ In other words, the more loans you have, the further your business revenue has to stretch to cover the payments on each loan.
Business owners who engage in loan stacking have been known to spend more than a quarter of their cash flow to cover debt payments. This becomes unsustainable, to the point where the business tries to take out more loans to pay back the old loans, entering a negative debt cycle.
Online loans, most of which require weekly or daily repayment, only exacerbate this problem. Paola Garcia, a small business advisor at Excelsior Growth Fund, a nonprofit lender in New York, says:
“Business owners assume payments will be monthly, only to find out these loans need to be repaid on a weekly basis. Many times, that leads a business owner to take out another loan—one that doesn’t build the business or the balance sheet, but rather exists only to help make payments on the loans already taken. Then the business owner ends up in a cycle of debt that is difficult to escape… with exorbitant interest rates and unmanageable repayment schedules.”
Eventually, when the business can no longer stay afloat with so much debt, the owner is forced to close shop. The situation is kind of like a block tower that keeps getting taller and taller until finally crumbling.
Even in cases where the borrower can comfortably repay multiple loans, the lender might prohibit loan stacking. In your agreement with your original lender, they’ll stipulate whether or not they allow you to take out additional loans before your loan with them is paid off. If not, violating that clause in your contract could automatically send you into default. (One of the many reasons it’s crucial to read the fine print.)
For instance, when you get a loan from an online lender, they usually file a blanket lien on your business assets and require a personal guarantee. With that type of lien, the lender has the right to sell off any of your business or personal assets to repay the debt. If you were to take on another business loan when you were contractually prohibited, you’d interfere with the lender’s lien and go into default.
The reason many lenders don’t allow loan stacking is essentially to make sure they won’t have to compete over collateral if there’s a default. An example? If you have multiple loans and can’t repay your debt, another lender might encroach on the assets your first lender is looking to seize. This can leave the first lender with less money if the borrower defaults. That’s why many online lenders have anti-stacking policies in their loan agreements.
With these policies, you can’t take out additional funding if doing so will affect the first lender’s lien on your assets. The first lender is in “first lien position,” and they won’t be willing to take a back seat to other lenders. (Remember, a lender always wants to make sure they have a way to collect on their loan—just in case.)
Every lender has different opinions on loan stacking. You can contact your lender or refer to your loan agreement to find out if they have an anti-stacking policy. And if they do, make sure you abide by it. Violating your lender’s anti-stacking policy by getting other loans can not only put you in default of the loan but also trigger all kinds of legal proceedings against you and your business.
If loan stacking is such a problem for lenders, then why do lenders let it happen in the first place? Can’t a lender just see when an applicant already has a business loan and turn them away?
In reality, things aren’t quite so simple.
New accounts and credit inquiries take up to 30 days to show up on a credit report. So, even if Lender B pulls an applicant’s credit, they might not know that Lender A has already approved the applicant for a loan—the applicant could end up with two loans. Technically, Lender B can find out about Lender A if Lender A has filed a lien on the applicant’s business or personal property. But many online lenders market themselves based on quick approval and underwriting and don’t take the time to do a lien search.
Unscrupulous lenders also contribute to loan stacking. There are companies that go through lien records every day just to prey on small business owners who need capital. Once you obtain a business loan from one lender, you could get calls from other lenders promising “low-rate financing.” David Bakke, a lending expert at Money Crashers, says, “Your business may be targeted by less-than-credible lenders who entice you into taking out more business loans. But you’ll typically be paying an even larger interest rate to cover the risk that the lender already knows you carry.”
The cost of starting a small business can run more than $100,000 depending on which industry you’re in. Once you’ve launched your business, there are dozens of operational expenses. And in today’s market, raw materials, wages, and other elements of doing business are only getting more expensive.
As capital needs rise for small businesses, the temptation to stack multiple loans increases. But if you take out a business loan and find yourself needing more capital, there are better ways to get more funding.
Here are three alternatives to loan stacking that can help you raise money:
The first thing you should do when facing a shortage of capital is to go back and contact the lender that issued your current loan. “Under the right conditions, they might approve you for more money,” says Fundera’s Hockenbrocht.
Most lenders have policies that allow borrowers to receive additional funding after they’ve paid back at least 50% of their original loan or made timely payments over several months. “However,” he advises, “be prepared to show the lender why you deserve more funding. If you’re asking for a significantly larger amount of capital, you should be able to support your request with higher business revenues and strong personal credit.“
Lenders will reevaluate your debt service coverage ratio (DSCR) when you go back for more money. DSCR measures how comfortably your company can cover debt payments. The formula for DSCR divides your business’s annual net income by your annual loan and interest payments. If your DSCR isn’t at least 1.2, after accounting for the additional funding, then you’ll need to come back to the lender once your business income increases.
Realize that there are limits here. If you’ve been late with payments on your current loan, for example, the lender is unlikely to grant your request for additional funds.
Another great alternative to stacking loans is to refinance your business loan. Your first business loan will give you the opportunity to grow your company’s revenue and profitability. And once you’ve built up a record of timely payments, your personal credit score will improve as well.
You can apply for a second loan from a less expensive lender. But instead of having two separate loans, the new lender will pay off the old lender, leaving you with just one loan and a lower interest rate. This is called refinancing.
As Corey Vandenberg, a lending expert who spent many years working with small business owners, explains, “Refinancing debt together in one payment is a great way to protect a business’s cash flow… Instead of making payments on five loans, you have just one, saving you the potential of being late on so many different bills, saving you money on interest, and usually resulting in a much lower payment.”
For example, let’s say you have an outstanding balance of $100,000 on a business loan from online Lender A. The loan has a high interest rate, but you’ve been diligently making weekly payments. Business is growing, and you’d like to borrow an additional $75,000. You approach online Lender B, which offers low interest rate loans. Lender B approves you for a loan of $175,000. They pay Lender A $100,000 out of that amount, and you now owe Lender B $175,000 at a low interest rate.
Loan stacking presents the biggest problem when a borrower has multiple loans with the same characteristics and repayment terms, or where multiple lenders have a security interest in the same asset.
However, it is possible for two distinct types of loan products to healthily coexist together. For instance, as consumers, many of us have both a home car and a car loan or a home loan and a student loan.
Examples of complementary business loan products include:
The reasons these combinations work is because the borrower uses the funds for different reasons, and the underlying assets/collateral are different for each loan. For example, let’s say you own a restaurant and have a short-term loan from an online lender and an equipment loan from your bank.
You’ll probably use the short-term loan to buy ingredients or supplies, and pay back this loan with daily or weekly payments over the course of a few months. The short-term lender probably placed a blanket lien on all of your restaurant’s assets.
Now for the bank equipment loan. You’ll use this loan to buy a new fridge for your restaurant and repay it with monthly payments over several years. The fridge serves as collateral for the loan, so if you default, the bank can seize and sell off the fridge to satisfy the debt. The short-term lender has rights to all your other business assets if you default.
The risks of loan stacking outweigh any potential benefits in almost all cases. This is one of the reasons Fundera belongs to The Small Business Borrowers’ Bill of Rights, a core tenet of which is to only provide loans based on a borrower’s ability to repay.
But there are a few cases where stacking loans is okay—even beneficial. As we mentioned above, some loan products play well together. Consider these advantages of having multiple loan products at once:
Javier Zalaf, the co-founder and director of Streamhealth Group, used multiple loans to grow his digital healthcare business. Zalaf says, “Stacking loans is all about balance and having a clear understanding of the terms of each loan you are taking. It is… something positive if managed well. It gives you the ability to leverage growth on someone else’s expense and puts the time value of money in your favor. At the same time, stacking loans for emergencies can be very risky and only create a larger problem. Stacking loans for growth is good, but for emergencies, best to avoid.”
Remember, business loans should work to your benefit. If you are stacking loans to fund growth, ensure that the debt will yield a meaningful return on investment for your business. For instance, if your monthly loan payments are $500, the loans should generate three to four times more in business revenues. Try our loan performance analysis to figure out how much revenue growth you need to justify taking out loans.
Of course, you should never take out a second loan if your current credit agreement prohibits you from taking on additional loans or other forms of credit. Even if you’re a good candidate for another loan, if you violate the terms set out by your current business lender, the lender will consider you in default on your loan. And that’s definitely not a position you want to find yourself in.
The takeaway: Loan stacking is usually too risky, unless you have a very fast-growing business and can afford to take on multiple loans at high risk. Even then, you should have a clear repayment plan, and the loans should maximize your business’s profits.
Stacking loans from multiple business lenders can have negative implications for your business. Yes, there are some situations where multiple loan products can make sense. But ultimately, the more loans you have, the less money you have to reinvest back into your business. The result can be an unending cycle of debt.
Just as bad, loan stacking might violate your loan agreement with your current lender. So, before taking on a second loan, approach your current lender to see if they can give you more funding. There’s also the opportunity to refinance in some situations. Maintaining an open line of communication with your current lender is your best bet when you need more capital to grow your business.
Priyanka Prakash is a senior contributing writer at Fundera.
Priyanka specializes in small business finance, credit, law, and insurance, helping businesses owners navigate complicated concepts and decisions. Since earning her law degree from the University of Washington, Priyanka has spent half a decade writing on small business financial and legal concerns. Prior to joining Fundera, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup.